China’s premature overheating

Commentary: Questions surface over Chinese growth numbers

HONG KONG (MarketWatch) — China began this year with an off-the-charts explosion in credit issuance. Last week, it broke records again, this time for the amount of cash drained from its banking system.

Beijing’s haste to apply the brakes has renewed fears the economy is already overheating.

The record credit issuance of 2.5 trillion yuan ($400 billion) in January — comprising both bank lending and non-bank financial institutions’ credit — always looked as if it was verging on the reckless.

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The surprise perhaps is that this reversal came so early. The central bank withdrew 910 billion yuan from the economy via open-market operations last week, its biggest weekly cash drain ever.

This action coincided with warnings from Beijing for local governments to keep a tight reign on property-market speculation, amid fears of bubbles reappearing.

It looks as if Hong Kong, at least, was listening. On Friday, the government further extended its existing battery of property taxes to try to take the heat out of the market. The new measures target non-residential property and buyers of second homes.

Authorities in Beijing don’t need to look far for evidence of an economy running too fast and into trouble.

In recent weeks, the Chinese capital has literally ground to a halt due to smog worsened by traffic and factories. Little wonder, when car sales jumped an incredible 46.4% in January to 2.1 million units from a year earlier.

Analysts now warn pollution threatens not just health but growth too.

Nomura says in a new report that pollution has got so bad, it may force policy change on the government, which will inevitably reduce growth in the short term. An unusual appendix in the report was a nationwide map of Particulate Matter (PM) readings.

Other areas where readings are flashing warning signs are with potentially resurgent inflation and property prices.

While the most recent January consumer-price data looked subdued with just a 2% rise, there is growing debate about the true level of inflation across China’s economy.

Anecdotal evidence when visiting China suggests things have gotten much more expensive over the past few years.

If you look at the number of companies either relocating or choosing to manufacture elsewhere, higher prices are clearly a factor. Foreign direct investment fell last year and continued its downward trend in January, declining 7.3%.

It has always been hard to square away China’s position as a low-cost manufacturing hub, while at the same time having some of the highest-priced real estate in the world.

Some economists have an explanation: The numbers are plain wrong.

Under this theory, not only has inflation been higher than reported, but real gross domestic product growth has also been lower.

Standard Chartered Bank’s Stephen Green questions if China’s growth in 2012 might have only been 5.5%, even as the official figure was 7.8%.

He gets a much lower GDP number because service-sector inflation has been systematically underestimated in both China’s GDP deflator and consumer-price-index figures. (A GDP deflator is used when calculating real growth, rather than just nominal increases in GDP caused by price increases.)

The failure to capture rising rents and service inflation in official statistics are to blame for this, says Green.

Official figures do not include any housing rental component and rely largely on residential utilities, which are often subsidized. Rents have been rising at least 10% a year, estimates Standard Chartered.

Service-sector inflation meanwhile is also missing in official data, including such items as hospital-bed rates, which have been rising at 10% a year for the past five years.

Green concedes his new data are only guesstimates, but it certainly gives pause for thought: How much of China’s prodigious growth numbers are explained by counting property bubbles, rather than growth in the economy?

If we rewind to last year, a repeated warning was that China’s stuttering economy needed structural reform, not just more lending stimulus. Otherwise, you will just get higher prices and not growth. It should then come as little surprise if this is what turned up.

The other concern with China’s credit surge in January is that over half of it came from largely unregulated shadow financing. In recent weeks — likely helped by the stock market recovery — it’s become popular to reclassify shadow financing as legitimate. If you missed it, this was in fact China’s financial liberalization.

But as fears over the economy overheating resurface, expect renewed scrutiny of this new credit issuance.

And if China’s inflation has been running at a higher pace than we thought, reining it in could prove more difficult. How soon before investors need to worry again about what landing lies ahead for China’s overheating economy?

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